Tuesday, November 12, 2002 :::
An interesting read about things the Fed can do after it gets the funds rate to 0. I've always felt 2 is unnecessary because 1 is available; 5 is actually very similar to 1, though that may not be obvious. Raising interest rates occurred to me about a year or two ago, mostly as a way of killing expectations that rates would keep falling; I acquired the sense somewhere that certain economic actors were waiting for rates to drop more before taking on debt, and if they lost that expectation they might act sooner. Mind you, at least in theory those expectations are reflected in the longer term interest rates before the drops occur, and these people should just take advantage of those long-term rates immediately, but it seemed possible to me that people wouldn't act on that as they should.
If marginal product of capital (in nominal terms) for a company is exceeded by its perceived default risk, no amount of rate cutting is going to make it better to lend to that company than to sit on one's cash. I really don't think we're at the point where a large portion of the productive economy is freezing because banks are simply afraid to lend anybody money -- which may have been the case in the Great Depression -- but if it gets to that point, deliberately creating significant inflation is the only thing that can be done.
(To end with a slight digression, someone who once (recently) worked in a bank told me of an old lady -- i.e. of Depression vintage -- who came into the bank twice a week, withdrew her entire account, counted the cash, and then redeposited it. Trauma can cause fear to exceed rational levels.)
::: posted by dWj at 12:20 PM
